Last Two Times After Our Dear Government Reported Data Like This, Stocks Crashed

Wall Street claims surge in stocks is based on rising corporate earnings.

So, let’s see. The Commerce Department’s Bureau of Economic Analysis released its third estimate of fourth quarter 2016 GDP and corporate profits today. This second revision of its first estimate of January 27 contains more data and is considered a more accurate approximation of what happened in the vast, devilishly hard-to-quantify US economy.

In terms of GDP, the fourth quarter was revised up slightly, but there were adjustments for prior quarters, and overall GDP growth for the year 2016 remained at a miserably low 1.6%. We’ve come to call this the “stall speed.” It’s difficult for the US economy to stay aloft at this slow speed. As Q4 gutted any hopes for a strong finish, GDP growth in 2016 matched the worst year since the Great Recession.

And corporate profits, despite a stock market that has been surging for years, are even worse. A lot worse. They’ve declined for years. In fact, they declined for years during the prior two stock market bubbles, the dotcom bubble and the pre-Financial-Crisis bubble. Both ended in crashes.

However, Wall Street remains assiduously silent on this.

The BEA offers various measures of corporate profits, slicing and dicing them in different ways. One of them is its headline number: “Corporate profits with inventory valuation and capital consumption adjustments.”

It estimates “profits from current production,” based on profits before taxes, not adjusted for inflation, but with adjustments for inventory valuation (IVA) and capital consumption (CCAdj).These adjustments convert inventory withdrawals and depreciation of fixed assets (as they appear on tax returns) to the current-cost economic measures used in GDP calculations.

It’s a broad measure, taking into account profits by all corporations, not just the S&P 500 companies. This measure is reflected in the first chart below. Later, we’ll get into after-tax measures without those adjustments. They look even worse.

In Q4, profits rose to $2.15 trillion seasonally adjusted annual rate. That’s what the annual profit would be after four quarters at this rate. But profits in the prior three quarters were lower. And so Q4 brought the year total to $2.085 trillion. This was down from 2015, and it was down from 2014, and it was up only 2.6% from 2013, not adjusted for inflation.

This 20-year chart shows that measure. Note that the profits are not adjusted for inflation, and there was a lot of inflation over those 20 years:

Things get even more interesting when we look at after-tax profits on a quarterly basis. The chart below shows two measures:

Q4 profits, at a seasonally adjusted annual rate, but not adjusted for inflation, were back where they’d been in Q1 2012:

By this measure, corporate profits have been in a volatile five-year stagnation. However, during that time – since Q1 2012 – the S&P 500 index has soared 70%.

It’s hard to blame oil: The price didn’t start collapsing until the fall of 2014. Earnings didn’t get hit until 2015. By mid-2016, oil was recovering. These dynamics have influenced the V-shaped drop and rise in 2015 and 2016. But the stagnation in the two prior years occurred when WTI was trading above $100 and occasionally above $110 a barrel!

The chart also shows that there were two prior multi-year periods of profit stagnation and even decline while the stock market experienced a massive run-up: from 1996 through 2000, leading to the dotcom crash; and from 2005 through 2008, which ended in the Financial Crisis.

This peculiar phenomenon – soaring stock prices during years of flat or declining profits – is now repeating itself. The end point of the prior two episodes was a lot of bloodletting in the markets that then refocused companies – the survivors – on what they needed to do to make money. For a little while at least, it focused executives on productive activities, rather than on financial engineering, M&A, and similar lofty projects. And it showed in their profits.

But that’s not happening now. Instead, executives are chasing after deals and paying record premiums to acquire other companies. And even data-provider Dealogic blamed stock market “exuberance” for driving merger valuations and premiums that have “soared to the highest level on record.” Read…. Why Does Pre-Collapse Year 2007 Keep Popping Up in M&A?

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54 comments for “Last Two Times After Our Dear Government Reported Data Like This, Stocks Crashed”

Paul

Mar 30, 2017 at 6:14 pm

I don’t think corporate profits are accurate. Profits are estimates based on long term assumptions on things like interest rates, depreciation assumptions and the rate of return on assets.

Which company out there that has taken on buyback debt is using higher interst rate assumptions? None. Which company is using realistic pension ROR numbers? None. The drop in interest rates added about $300 billion to the to the earnings number.

What’s propping the markets up is an 8 year money flood, combined with the continual flood of cash from the ECB and insane borrowing by the Chinese. The end will not come with a market crash here. It will come, as it already has in places like Greece, with S&P downgrades on soverign debt. It will start in places like Egypt, India and Turkey.

akiddy111

Mar 30, 2017 at 11:01 pm

“The end will not come with a market crash here. It will come, as it already has in places like Greece, with S&P downgrades on soverign debt. It will start in places like Egypt, India and Turkey.”

I don’t think it matters where it starts and ends. The global economic system just has to clear and it will do that when it reaches a level a lot lower than where we are at right now.

Central banks are making things up as they go along. The party will end when everyone wants access to their money … at the same time.

Margin debt reached all time highs in February at $528b.

just for perspective :

It hit $381b in 2007 and $278b in 2000

Unitron

Mar 31, 2017 at 8:33 am

There are many problem areas ready to implode, but I think China is first on the list. The China Interbank Rate is the one to watch, because it’s the first indicator of what will be a worldwide liquidity crisis, and coincidentally, plummeting stock markets all over the world.

Paul

Mar 31, 2017 at 9:30 pm

I agree. China is borrowing as much per month as the US does per year. But China and India have the same problem. Too many people. China went from burning 1.1 billion tons of coal a year in 1997 to 4.6 billion today. Even a drastic cut, 30% only takes them to a level 3X higher than is sustainable. I have a good friend that imports food to Bejing. They’re killing each other. Eggs and rice made out if plastic, baby milk filled with arsenic. The country hasn’t a shred of morality. 1/4th of the population still shits in a hole. People north of Shanghai wear masks all the time. The country os going into a self genocide. The funny thing is, it’s worse in India.

Robert

Mar 31, 2017 at 10:23 am

“Margin debt reached all time highs in February at $528b. just for perspective : It hit $381b in 2007 and $278b in 2000M”
The issue of margin debt is interesting, but for me, problematic- are you talking about U.S. margin debt, or total in all world markets? For my own observation- and this is based very anecdotally on general observations,including number of comments on various stock chat boards, is that a lot fewer people are in the market since 2008- so who is doing all this buying on margin? I have my doubts.

Robert

Mar 31, 2017 at 10:27 am

An an afterthought, all the brokerages have, just this year dramatically lowered their commissions for share purchases: does this sound like people are beating the doors down to buy stocks?

Margin debt, as published by the NYSE which gets this info from broker-dealers, is at a record, even when adjusted for inflation. Growing margin debt drives up stock prices (the accelerator of leverage); but when stocks fall, margin debt gets trimmed by selling off stocks, often “forced selling” via margin calls from brokers, creating a downward spiral. There has been no crash in recent decades unless there was high margin debt (high leverage). That condition has now been amply fulfilled.

cdr

Mar 31, 2017 at 12:11 pm

Wolf Richter,

Agree wholeheartedly with your logic. I believe I even wrote something similar in days gone by. The problem at that time was The Fed and a Bullard moment or maybe another Fed head shrieking about the need for another QE when the market dropped a tad and margin calls appeared obvious to all who looked in that direction. Hence a recovery followed by more upside and the Trump rally. The Fed Put is being taken for granted now regardless of current statements by Fed Heads.

The Fed will allow the market to reflect reality long past when my cold dead hands will be able to earn a decent level of interest in a normal way.

DickS

Apr 3, 2017 at 12:42 pm

“I don’t think it matters where it starts and ends. The global economic system just has to clear and it will do that when it reaches a level a lot lower than where we are at right now.”

So true, right now, there’s more price discovery on eBay and/or Craigslist than in the global markets. There has been no ‘clearing’ over the past 80 to 9 yrs during CB QE induced ‘markets’.

jerry

Mar 31, 2017 at 3:54 am

I agree Paul

cdr

Mar 31, 2017 at 7:34 am

I mostly agree with Paul, but am even more pessimistic about what it will take for over-valued markets to deflate. The liquidity floating around is massive and rates are still too low to be considered as anything but excessively easy.

If and when rates normalize with respect to historical levels – perhaps 4% to 5% 30 year UST, this will be a first level condition. At that price, HFT will need to make a lot more per trade or use their own money to make a profit.

2nd, the Fed needs to reduce it’s balance sheet, even it all they do it allow securities to mature without replacement.

Even so, the ECB will never stop QE and rate management since the Eurozone will cease to exist when they do. Their farce will continue until it can’t, and this will be many years down the road.

Japan is a sideshow. Their plans are inscrutable and appear to rely on made up theories that support printing money to get by.

Markets will not fall for years regardless of what the historical record implies. Even if they make croaking noises, the Fed will run back in for protection. Academics will concoct new theories that support them just as the Democrats concoct Russian theories that the mainstream support.

paul

Mar 31, 2017 at 9:37 pm

cdr, I can’t understand why the feds balance sheet matters. Not saying it doesn’t, just that I don’t understand it. First, who has 2.4 trillion to buy the feds assets? Second, who cares who owns it?

The fed’s balance sheet barely frew between 1990 and 2009. It wasn’t until the lehman crash when they were fored to stabalize fannie and freddie debt that they started buying.

This money was created by trade deficts, not the fed. It was banks monitizing inventory, accounts recievable and accounts payable on worldwide free trade. All that “money” is still sloshing around.

George McDuffee

Mar 30, 2017 at 6:24 pm

But things are different this time…

Curious Cat

Mar 30, 2017 at 7:15 pm

I have some very rare tulip bulbs I’d like to sell if anyone is interested.

RE: … of what happened in the vast, devilishly hard-to-quantify US economy.
—–

Two observations about this seemingly innocuous phrase:

* First, we need the financial equivalent of the NTSB [National Transportation Safety Board] which will evaluate all major business failures, which like the NTSB, will have full subpoena powers, and and can compel testimony. The NFSB [National Financial Safety Board?] over time will acquire a competent investigative staff as skilled in bankruptcy evaluation, as the NTSB experts are in evaluating plane crashes. The proposed NFSB,like the NTSB, can also utilize available government expertise [e. g. IRS, Treasury, FBI, Comptroller of the Currency, FDIC, etc.] to determine what went wrong. They should also be tasked with the timely publishing of their findings, and suggesting legislative/regulatory changes to prevent (or at least reduce the chances of) of the identified type of bankruptcy/insolvency from happening again.

* Second, we already capture enough of the economic and financial data required for a much finer and more immediate analysis, and the required analysis tools, equipment, and expertise is available, although it may require some expansion. WHAT WE LACK IS THE WILL TO DO SO. Specifically this data currently includes, but is not limited to, bank money transfer [SWIFT] data, exchange [stocks, bonds, commodities, FX, derivatives, etc.] trading/issuance data, including the “dark pools,” and credit/debit card transaction data.

The Pareto principle states that, for many events, roughly 80% of the effects come from 20% of the causes. As all of the major players in the various economic sectors are already heavily “computerized,” it would seem to be no great leap to requiring them to frequently [daily?] submit production data, capacity utilization, actual headcount, current AR/AP data, etc. in a standard format.

d

Mar 31, 2017 at 4:35 am

This concept itself is not stupid.

The issue becomes how and where to apply it when dealing with P 45 DEREGULATE.

And the bugbear of all bugbears in America The constitutional wright to.

So who’s going to buy from all those that bought on margin?? Record margin levels.

chris Hauser

Mar 30, 2017 at 9:45 pm

i don’t see that in the charts, but i’m iffy on prices right now.

if you have spare cash to lock up for a good bit over the horizon, some prices are fair.

i’m kinda partial to non to lightly regulated utiliies, if you know what i mean…….

by the way, whatever happened to that elliott wave fellow?

or, could i get a peek at harry dent’s balance sheet?

Streetwise

Mar 30, 2017 at 10:13 pm

Great site but you state

“Note that the profits are not adjusted for inflation, and there was a lot of inflation over those 20 years”

Mostly as healthcare but as you know companies get to deduct their healthcare costs from their taxes. The larger the cost, the larger the deduction.

As the stockmarket is forward looking, the plunge in crude will continue to help going forward. Expect oil to hover around $40 for the next few years. The market sees this
, (as well as tanking commodities), and incorporates into stock prices.

If the economy tanks stocks will rally on low interest rates, if it soars then stocks go up on good fundamentals.
There is no shortage of cash to prevent stocks from rising for years to come (thanks FED!).

You’re in a bull market that can never end! The FED is not like gravity, it is made by the minds of men and is doing exactly what it was designed to do- bring prosperity to all!

This is exactly what’s scary. I hear these statement a lot these days. I heard them a lot before, in 1999 and 2007.

But I’m relieved you meant it in a sarcastic way, or did you?

Camerons

Mar 31, 2017 at 1:04 am

An investor once said “Price is what you pay. Value is what you get. ”
I think the concept of value may not be well understood by those who see the markets go up uninterrupted indefinitely. Like you I recall hearing statements like “You’re in a bull market that can never end!” before previous crashes. They also remind of the famous Yale economist who said “Stock prices have reached what looks like a permanently high plateau,” before the Great Depression market crash. He did not understand value and therefore did not understand price.
I don’t know when the market will crash but I’m certain it will.

Jerry Bear

Mar 31, 2017 at 8:15 pm

If the stock market does nothing but rise then the value of the money must do nothing but inflate, especially, when, as now the price rise is not backed by increased productivity. Eventually peoples’ faith in the meaning of their money gets shaken and the whole house of cards comes crashing down.

Robert

Mar 31, 2017 at 10:33 am

Have a look at the link to the Caracas Stock Exchange. If there ever was a country that served as a bad example, it is Venezuela, and yet their stock market has been hitting one all time high after another. What does that tell you? https://www.bloomberg.com/quote/IBVC:IND

What that tells you is that the currency in which the stock market is denominated, the Venezuelan bolívar, has been collapsing, and that its collapse is accelerating. Venezuela has hyperinflation of around 1,500% annual currently. So if you look at the stock index, you’re looking at a measure of hyperinflation. And that’s about it.

Bobber

Apr 1, 2017 at 11:12 am

Fear of hyper-inflation could be driving the U.S. stock market as well. In the age of money-printing, you have to have some money in assets like stocks or real estate. You can’t be fully in CDs or your wealth could be inflated away.

Who the heck can retire in this climate, when your savings can go away because of Fed fools? People need to keep working unless they have a huge wad in the bank.

interesting

Mar 31, 2017 at 2:07 am

“As the stockmarket is forward looking”

I always laugh when i read that. Maybe before the computers took over but now How can anyone say that with a straight face? The stock market IMHO, at least since 2000, has little to do with the real economy. With all the free money for banks and even some governments trading it’s just a crap shoot.

mean chicken

Mar 30, 2017 at 10:36 pm

Mission Accompliced!

CH

Mar 30, 2017 at 11:44 pm

This market does remind me of the “Dot Com” days with unrealistic valuations, with a touch of “irrational exuberance” as Greenspan said back in ’96, – it just seems too risky to invest at this time.

I’m curious how readers are invested, or playing this market, – ideas? – Seems like day trading a small amount is one way to play it.

Petunia

Mar 31, 2017 at 9:22 am

I wouldn’t want to be anywhere near the market in general, but I think Amazon and UPS are the two best run companies in America. And my mad money long term bet would be on Elon Musk and anything he’s doing, Tesla, SpaceX, etc.

MaxDakota

Mar 31, 2017 at 9:41 am

Sold all our stocks a few months ago. There are a few privately held companies I believe in, like the German discount supermarket chains, but can’t buy their stock! Even companies whose products I believe in, like Tesla, seem to me to have absurdly high valuations so am not investing. Basically, I don’t believe in the stock market anymore.

Bellinghouse

Mar 31, 2017 at 9:59 am

I am only 52% in stock (mostly non-US and Emerging Market) index funds, and 48% cash. Lowest stock allocation in years, having sold down from 80% stock / 20% cash over the last year. I am 57. Fortunately most of my portfolio is in retirement accounts, so very little tax hit.

I do not like having this much cash, but I was concerned about US Stock valuations, so I sold down to a level that I was comfortable with. If we get a 20-30% decline in the market, I will be increasing my stock allocation once again. I see no purpose for bonds at the lowest interest rates in my lifetime.

william

Mar 31, 2017 at 10:55 am

Mostly cash. Waiting for market top to be followed by a 30% decline which can take 18 months to achieve in total. I don’t expect to re-enter the market until possibly 2019, at which I’ll dollar-cost average back in.

I have one individual stock I am accumulating share quarterly, TASR.

Real estate is my primary investment activity today.

Insta

Mar 31, 2017 at 8:49 pm

I moved out of stocks to cash about 2 yrs ago. I fully expect the coming crash to happen in the next 2-3 years, maybe sooner and then when it reaches what I perceive as average longterm value I will reinvest.

Doing some simple observation on the last hundred year the rough average bull-market is about 6yr, with a bear market of at least 25% drop within 1-6 yrs after this. Most of the time it is within a total of 10 yrs. SO, I figured if I get out after 6yrs and stock market continues up at 16%/yr before dropping 25% in a bear market, I will be money ahead even if I’m out for 3 yrs. If it takes 4 years of 16%/yr gain and then only drops 25%, then I would be a few percent behind.

If you are still in the market and think it will crash in the next 3 yrs, what is the point? Especially because I believe that fair value is less than half of current SP500 total. Since I fully expect much more than a 25% drop I am happy enough to wait longer.

CH

Apr 1, 2017 at 2:31 am

Good point, and I have thought the same, – If you believe it’s going to crash then why invest? – Wait for the inevitable crash and wait till it bottoms out, then invest, and have some long term puts.

Doug Kass called the bottom in 2009, and the DJI has gone up about 3x since.

It just seems that if there is a Deutsche Bank (DB) default, or BREXIT mishap, or war in M-E, NK, or this Russia probe has legs, etc, – it will have a effect that derails everything, it’s been due, DB alone with all it’s derivatives estimated at 47 Trillion could be the catalyst that takes it all down, like Lehman did, but much worse!

I think I will stick to cash and do cautious small amounts of daytrades, Long term investing is way too risky, maybe swing trades of a couple days is also a good way, – I cashed outta this poker game a few years back.

d

Apr 1, 2017 at 3:43 am

“I think I will stick to cash and do cautious small amounts of daytrades, Long term investing is way too risky, maybe swing trades of a couple days is also a good way, – I cashed outta this poker game a few years back.”

Day trades with tight trailing stops you only have to be correct 4 in 10, if you run a 2 to 1 RR ration.

Its the only way to trade most markets today I do indexes and a few selected commodities/metals.

Is seem to get better than 4 in 10 winners on average. When a winner gets into profit, many time’s you can let it run until it stops itself out.

Beau

Mar 31, 2017 at 12:32 am

I just don’t see things stopping. Whether it be Vancouver real estate (where I live), or the stock market, shit ain’t going down.

People have been saying the real estate market in Vancity will crash for over 10 years…so far, no good. I’ll believe it when I see it. And even if it actually does crash 50%, no locals could afford to buy a house as prices would still be out of reach. Fuck this world.

Alex noobovsky

Mar 31, 2017 at 2:07 am

Just relax. It’s new normal.

Bobber

Mar 31, 2017 at 8:55 am

Stocks are looking shaky relative to other assets. Interest rates will probably rise gradually. Valuations are at historical highs on many measures. Fixed income now pays more than a dividend yield on the S&P 500 and fixed income is now slightly beating the inflation rate. Anybody with a brain would be bailing out now. The stock market crash could occur any time in my opinion.

GSH

Mar 31, 2017 at 10:14 am

The future does look very bright since we (re)discovered the miracle of money printing.

akiddy111

Mar 31, 2017 at 10:47 am

If we use the S&P 500 as a proxy for the stock market, it can be reliably illustrated that stock market valuations are higher than they have been over AT LEAST 95% of the last 100 years.

The likelihood of a broadly diversified basket of equities generating a Positive total nominal return over the next 5 years is slim.

OTOH, the probability of us seeing a bear market (20% drop) is reasonably high.

If anyone disagrees, i would love to hear from you.

Petunia

Mar 31, 2017 at 11:20 am

See my comment below, about S&P.

Bellinghouse

Mar 31, 2017 at 3:22 pm

I agree with you. That is why my equity holdings are largely Europe, Japan and Emerging Markets. Valuation metrics (p/e, p/b, p/s, and p/cash flow) are generally reasonable in those markets, and assuming we get inflation from continued loose monetary policy, should act as a good hedge for inflation (in the long term, not necessarily the short term).

mean chicken

Mar 31, 2017 at 10:59 am

Long SNAP from low $19’s at the moment, awaiting the moonshot. With small positions in KBR/PI/TAHO, stalking JMEI

Petunia

Mar 31, 2017 at 11:19 am

You can’t use the S&P 500 to represent the market for the last 100 years because current valuations are manifestations of the IPO M&A factory. I don’t think any of the original 500 listed in 1957 are even on the list. 95% of the companies on the list were listed since 1980, and if you go back to 1970, it’s only a handful that have been there longer.

So even though you comparison is not useful, you are still correct, the prices are crazy.

akiddy111

Mar 31, 2017 at 11:28 am

Petunia,

Did people tell us to ignore lofty valuations in 1999 ?

To ignore real estate valuations in Miami, Phoenix and Vegas in 2006 because of scarcity of inventory ?

What were the total nominal returns of the S&P 500 between 2000 and 2012 ?

0% ? 1% ? 1.5% ?

What were the draw downs 50% 60%

Personally, i do a lousy job of ignoring valuations. Others may have better luck.

akiddy111

Mar 31, 2017 at 11:20 am

One last thing.

When, not if, the market violently sells off… which is hard to imagine right now… everyone and their mother will be clamouring at the same time to get the opinion of people like Wolf Richter on subjects like precious metals, central banks, short sellers etc..

It always works that way.

Bobby

Mar 31, 2017 at 6:56 pm

a fat finger will hit one two many zeros again and tumble the house of cards.. Maybe we don’t need a reason, or debate a reason to look out for?

2021 could be the bottoming out year for a fresh bull market, given the over all slump in world economic cycle, with a longer bear market between 2017 and 2021 start. In and out, with 5-10% of portfolio could be a safe bet.